Healthcare and Competitiveness

There are some important and subtle points in Greg Mankiw’s discussion of healthcare fringes included in compensation. Note that if wages are NOT sticky, then Summers is wrong both short and long term. It worries me a bit that Larry Summers would get an elementary issue like this wrong. Maybe it is because is has been charged with explaining a policy he doesn’t agree with?

NEC director Larry Summers and CBO director Doug Elmendorf are old friends of mine and great economists. On most things, they agree. But compare these passages regarding the economic impact of healthcare costs.

First, Larry from yesterday’s talk at Brookings:

moving away from foreign debt-financed growth is only one component of ensuring a healthy expansion. An additional component is addressing our healthcare system. It is no accident that the period of the most rapidly rising wages for middle income families was the 1990s when healthcare cost inflation was relatively well controlled. Our ability to produce competitively in the United States will be enhanced if we contain healthcare costs. I have heard it said that GM’s largest supplier is not a parts company or a tire company, but Blue Cross Blue Shield.

Then, Doug from Senate Testimony a few weeks ago:

Some observers have asserted that domestic firms providing health insurance to their workers incur higher costs for compensation than do competitors based in countries where insurance is not employment based and that fundamental changes to the health insurance system could reduce or eliminate that disadvantage. Although U.S. employers may appear to pay most of the costs of their workers’ health insurance, economists generally agree that workers ultimately bear those costs. That is, when firms provide health insurance, wages and other forms of compensation are lower (by a corresponding amount) than they otherwise would be. As a result, the costs of providing health insurance to their workers are not a competitive disadvantage for U.S.-based firms.

I score this one for Doug.

Ultimately, what matters to firms is the compensation they pay workers. The composition of compensation between cash wages and fringe benefits like healthcare does not matter for the firms’ costs of production. In short run when cash wages are sticky, the cost of healthcare may affect competitiveness: Lower costs of fringe benefits would reduce compensation and thus reduce firms’ cost of production. But in the long run, compensation is set by supply and demand in labor markets. If more compensation is paid in the form of fringe benefits like healthcare, less is paid in the form of cash. And if less is paid in fringes, more is paid in wages.*

Let me put the point in the context of General Motors: If, for example, the U.S. taxpayer were to assume all the workers’ healthcare costs through a policy of national health insurance, GM would immediately become more competitive. Because cash wages would not be immediately renegotiated, compensation paid by the firm would fall, so costs would fall. But in the longer run, the workers via their union would most likely not be satisfied seeing GM pay lower compensation, so cash wages would start rising. (Those higher wages would help workers pay the higher taxes that would be needed to finance the national health insurance). GM would lose the competitive advantage it temporarily enjoyed.

The bottom line: Larry would look right in the short run, but Doug would look right in the long run.
* Larry makes precisely this point about wages and healthcare costs in his sentence about the 1990s, without seeming to notice that it belies his very next sentence about competitiveness.